Bull Market or Just Bull?

Last week, the Dow closed at 10,741, up some 64 percent since its 2009 lows, [03/19/10,
Yahoo! Finance] when most markets had priced in the likelihood of financial
Armageddon. As the markets have rebounded from the brink of disaster, many
Wall Street cheerleaders have proclaimed the dawning of a major new bull
market. If we measure market cycles biannually, and if bull markets need
not eclipse peaks achieved in previous cycles, then this forecast is spot
on. Of course, most investors are not saving for next week, but for homes,
college tuitions, and retirements. For these longer term investors, the euphoria
of the current rally may soon turn to despair when the market faces the unsavory
fundamentals of a second financial crisis.

We have long raised the point that, in general, the political, economic, and
financial fundamentals of our new mega-government era do not support a sunny
long-term outlook for U.S. stocks. Today, the S&P 500 trades at 21.6 times
current earnings, which is 32% higher than the average over the last 30 years. [03/24/10,
multipl.com] With so much economic uncertainty on the horizon, I'm not
sure how you make the case that the market is still undervalued. The nature
of the recent stock price move appears to be that of a bear-market rally, not
a bull-market resurgence.

Politically, this past Sunday's passage of mandatory health insurance for
all U.S. citizens, popularly dubbed 'Obamacare,' causes the greatest worry.
None of the fundamental problems confronting the American healthcare sector
were adequately addressed by this reform. Instead, government controls were
increased and entrenched, and expensive new entitlements were offered to the
voting public. Far from cutting the deficit, the costs of the new plan are
likely to deepen deficits indefinitely. The Wall Street Journal reported
Monday that the cost would be $940 billion over the next decade. The President,
in speaking of the new health measure, declared that "[t]his is only a first
step." As in most socialist regimes, grand promises of milk and honey first
win the popular vote, leading to bureaucracies that diminish, if not eradicate,
individual freedom of choice.

The American free-enterprise model has been used by myriad nations as an ideal
for economic growth and prosperity. As a reward, the United States served for
many years as the darling of international investors. On the other hand, socialism
has failed everywhere it has been tried. An America rapidly devolving toward
socialism will unquestionably act as a disincentive to international investors.
Increasingly, foreign funds will be withdrawn from our shores and taken to
parts of the world that embrace capitalism.

Economically, the United States and European Union, and many of their constituent
states, are among the world's most flagrant debtors. These debts are not being
used to invest in profitable endeavors, but rather in welfare hand-outs and
make-work projects. Worse still, these governments are adding new debt with
such speed and volume that Moody's has begun to issue warnings on their previously
untouchable credit ratings. Besides introducing tremendous regime uncertainty
into the markets, spendthrift fiscal policy has the added harm of crowding
out corporate and private borrowers.

The private sector can ill-afford this deprivation. While corporate earnings
have risen substantially since the country began careening toward recession,
this has largely been achieved by layoffs, improvements in inventory controls,
and consolidated product lines. With top-line sales decreasing, the ability
to produce rising profits by slashing costs cannot continue for long. We're
looking for another wave of corporate bankruptcies as the anticipated V-shaped
recovery fails to materialize.

The technical situation of the U.S. stock market looks similarly fragile.
The 64 percent rally from the lows of early 2009 appears overbought. The fact
that it has occurred on very light volume makes today's prices even more tenuous.
That the rally may continue of its own momentum through the spring does not
alter the poor fundamentals.

While stocks continued to move upward last week, the market is sensitive to
Greece, Portugal and Europe's debt problems, as well as political and economic
problems at home. There is some job recovery, but far too little. Corporations
and governments are depending on a miraculous economic boom to remain solvent.
When the Fed finally allows interest rates to reach more appropriate levels,
look for the glass floor to begin cracking. It is comforting to think bullish,
but, for now, the aura of recovery is just so much bull.

As an aside, all investors should keep in mind 'opportunity costs' as a matter
of regular portfolio review. Although domestic stocks appear to have put in
a rock solid performance over the past 12 months, one must weigh the outcome
against asset classes around the world. Many may assume that the gains are
unique to America when, in fact, other markets may have had largely better
performance. Investors should bear in mind this opportunity cost to ensure
they do not remain exclusively in the U.S. at the cost of perhaps missing investments
found in China, India, Canada, Australia, and other attractive markets.

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John Browne is the Senior Economic Consultant for Euro Pacific
Capital, Inc. Mr. Brown is a distinguished former member of Britain's Parliament
who served on the Treasury Select Committee, as Chairman of the Conservative
Small Business Committee, and as a close associate of then-Prime Minister Margaret
Thatcher. Among his many notable assignments, John served as a principal advisor
to Mrs. Thatcher's government on issues related to the Soviet Union, and was
the first to convince Thatcher of the growing stature of then Agriculture Minister
Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously
pronounced that Gorbachev was a man the West "could do business with." A graduate
of the Royal Military Academy Sandhurst, Britain's version of West Point and
retired British army major, John served as a pilot, parachutist, and communications
specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military,
John has a significant background, spanning some 37 years, in finance and business.
After graduating from the Harvard Business School, John joined the New York
firm of Morgan Stanley & Co as an investment banker. He has also worked
with such firms as Barclays Bank and Citigroup. During his career he has served
on the boards of numerous banks and international corporations, with a special
interest in venture capital. He is a frequent guest on CNBC's Kudlow & Co.
and the former editor of NewsMax Media's Financial Intelligence Report and
Moneynews.com. He holds FINRA series 7 & 63 licenses.